Fund flow statement is a statement which shows the sources and uses of funds for a period of time. It is a method by which we study changes in the financial position of a business enterprise between the beginning and ending financial statement dates.
According to Anthony “the fund flow statement describes the sources from which additional funds were derived and the use to which these sources were put.”
The basic purpose of a fund flow statement is to reveal the changes in the working capital on the two balance sheet dates. It also describes the sources from which additional working capital has been financed and the uses to which working capital has been applied.
USES OF FUND FLOW STATEMENT
Following are the uses of fund flow statement –
- Helps in the analysis of financial operations – The fund flow statement discloses the causes for changes in the assets and liabilities between two different points of time and also the effect of these changes on the liquidity position of the company. Sometimes a concern may operate profitability and yet its cash position may become worse. The fund flow statement gives a clear answer to such a situation explaining what has happened to the profits of the firm.
- Helps in the formation of realistic dividend policy – A fund flow statement helps in the formation of realistic dividend policy in those cases when sometimes a firm has sufficient profits available for distribution as dividend but yet it may not be advisable to distribute a dividend for lack of liquid or cash resources.
- Helps in proper allocation of resources – A projected fund flow statement made for the future helps in making managerial decisions regarding the best use of resources. The firm can plan the expansion of these resources and allocate them among various applications.
- Future guide – Fund flow statement also acts as a future guide to the management. The firm’s future needs of funds can be projected well in advance and also the timing of these needs. The firm can arrange to finance these needs more effectively and avoid future problems.
- Helps in knowing the creditworthiness of a firm – All financial institutions ask for a fund flow statement before granting loans to know the creditworthiness and paying capacity of the firm. So if a firm seeking financial assistance from these institutions has no other option than to prepare a financial statement.
LIMITATIONS OF FUND FLOW STATEMENT
Fund flow statement has a number of limitations as well and those are as follows:
- Fund flow statement is not a substitute for an income statement or a balance sheet. It only provides additional information regarding changes in working capital.
- It is historic in nature which means they provide data on the basis of past records and it cannot be much accurate.
- It does not have that much importance than cash flow statements as it only shows the changes in working capital.
- It cannot reveal continuous changes.
- Fund flow statement is not an original statement but simply a rearrangement of the data given in the financial statements.
SOURCES OF FUNDS
Some of the most important sources of funds for a business are as follows-
FUNDS FROM OPERATIONS OR TRADING PROFITS
Funds from operations are one of the main sources of funds. Sales are the main source of inflow of funds as they increase the current assets. The net effect of operations will be a source of funds if inflow from sales exceeds the outflow for expenses and the cost of goods sold and vice-versa. It should be noted that the funds from operations do not necessarily mean the profit as shown by the profit and loss account.
There are two methods of calculating funds from operations-
1. The first method is to prepare the profit and loss account considering only fund and operational items which involve funds and are related to the normal operations of the business.
2. The second and most used method is to proceed from the figure of net profit or net loss as arrived at from the profit and loss account already prepared.
FUNDS FROM THE ISSUE OF SHARE CAPITAL
When there is an increase in the share capital, whether preference or equity, it means capital has been raised during the year. The issue of shares is a source of funds as it shows the inflow of funds.
Net proceeds from the issue of share capital are also a source of funds.
Although the following should be considered –
- Making of partly paid shares as fully paid out of profits in the form of bonus shares is not a source of funds.
- Issues of shares for other than current assets such as against purchase of land, machine, etc. do not amount to an inflow of funds.
- Conversion of debentures or loans into shares also does not amount to an inflow of funds
ISSUE OF DEBENTURES AND RAISING OF LOANS
The issue of debentures and raising of loans results in the flow of funds into the business. However, loans raised for consideration other than a current asset, such as for the purchase of a building, will not constitute inflow of funds because in that case, the accounts involved are only fixed non-current.
SALE OF FIXED ASSETS AND LONG TERM OR TRADE INVESTMENTS
When any fixed or non-current assets like land, building, plant, etc. are sold it generates funds and becomes a source of funds. But when one fixed asset is exchanged for other fixed assets than it cannot be considered as inflow of funds.
NON TRADING RECEIPTS
Any non-trading receipt like dividend received, refund tax, rent received, etc. also increases funds and is treated as a source of funds because such an income is not included in the funds from
DECREASE IN WORKING CAPITAL
If the working capital decreases during the current period as compared to the previous period, it means that there has been a release of funds from working capital and it constitutes a source of funds.
FUND FLOW ANALYSIS
Fund flow analysis is the analysis of the flow of funds from current assets to fixed assets or current assets to long term liabilities or vice-versa. Fund flow statement analysis is one of the basic tools for stock analysis. Fung flow statement analysis helps investors in identifying the key areas of utilization of funds for the company during any period along with the key sources of funds.
Funds flow analysis provides great help to investors in finding companies, which are giving loans to promoters/ related parties, etc. The movement of funds in the company’s balance sheet can be assessed by doing a comparative assessment of different sections of the balance sheet. It should be prepared by comparing the change in the value of their previous year and the current year.
- Equities and liabilities – Any increase in the liabilities section mean that the company has received funds and vice-versa when there is a decrease in the liabilities section.
- Assets – Any increase in the asset section means outflow of funds and vice-versa when there is a decrease in the asset section.